NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'BB+' rating on the following revenue bonds issued by the Colorado Health Facilities Authority on behalf of National Jewish Health (NJH):
--$22,640,000 series 2012 fixed-rate bonds;
--$10,700,000 series 2005 variable-rate demand bonds (VRDBs).
The series 2005 VRDBs are secured by a letter of credit (LOC; UMB Bank, National Association).
The Rating Outlook is Stable.
SECURITY
Pledge of gross revenues (excluding restricted charitable donations and grants) and a debt service reserve fund.
KEY RATING DRIVERS
WEAK 2014 FINANCIAL RESULTS: NJH posted a $12.3 million operating loss (a negative 6% operating margin) in the fiscal year ended June 30, 2014, a decline from 2013. Through the six-month interim period ended Dec. 31, 2014, NJH narrowed operating losses to a negative 4.9% operating margin.
ST. JOSEPH HOSPITAL JOA: In December 2014, NJH established inpatient services at the newly opened campus of St. Joseph Hospital (SJH), an acute care hospital in downtown Colorado that is part of the Sisters of Charity of Leavenworth Health System (SCLHS; revenue bonds rated 'AA-'). The move was part of a joint operating agreement (JOA) signed with SJH and SCLHS in August 2014. Under the JOA, NJH and SJH revenues in Colorado will be combined, with NJH receiving a fixed percentage of the JOA's operating income. While there is some uncertainty regarding the future income from this arrangement, Fitch views the JOA as a credit positive, believing it can accrue material financial benefits to NJH by providing access to a larger patient base, reducing capital needs (NJH was planning for a new inpatient tower), and helping to spread fixed costs.
LEVERAGING OF HIGHLY SPECIALIZED SERVICES: The JOA with SJH is a major part of NJH's strategy to expand its clinical presence via agreements with both regional and national providers, with the goal of leveraging its status as a national leader in the treatment of complex respiratory diseases and related illnesses. Over the last two years, NJH has signed agreements with Banner Health (revenue bonds rated 'AA-'), Icahn School of Medicine at Mount Sinai (affiliated with Mount Sinai Hospital, revenue bonds rated 'A'), and Rocky Mountain Children's Hospital. Fitch views this strategy positively, believing it can further enhance NJH's national reputation while providing additional revenue opportunities.
ADEQUATE MTI MADS COVERAGE: Coverage of maximum annual debt service (MADS) as calculated by Fitch has historically been weak and was a very low 0.6x in fiscal 2014. However, MADS coverage as calculated under the Master Trust Indenture (MTI) continues to be satisfactory and was 2.1x in 2014.
RATING SENSITIVITIES
FINANCIAL IMPROVEMENT EXPECTED: Fitch believes the SJH JOA and other affiliation activities should lead to clinical revenue growth over 12 to 24 months. An improvement in NJH's operating profitability coupled with a rebuilding of its balance sheet could result in a return to the investment-grade rating category.
ADEQUATE MTI COVERAGE OF DEBT: The Stable Outlook is predicated upon Fitch's expectation that NJH will continue producing sufficient net income available for debt service as calculated under the MTI. A deterioration in debt service coverage as per the MTI from 2014 levels could pressure the rating.
CREDIT PROFILE
NJH is a national referral medical institute engaged in patient care, medical research, and teaching, primarily in the areas of respiratory, cardiac, allergic, and immunologic medicine. NJH has historically provided most of its services on an outpatient basis, but the majority of NJH's inpatient services are provided at SJH's new hospital beginning December 2014. Total revenue for fiscal year ended June 30, 2014 was $204.9 million.
Weak 2014 Results
As anticipated at the time of Fitch's review, fiscal 2014 profitability was weak with a negative 6% operating margin compared to a negative 4.4% and negative 4% in fiscal 2013 and 2012 respectively. Profitability in fiscal 2014 was largely impacted by growing expenses as the organization invested heavily in its clinical and research programs and physicians. Losses from research also continued to dilute profitability. Management is implementing plans to reduce the research subsidy to below $20 million over the next three years (from $22 million-$23 million historically) through expanding/diversifying funding sources, targeted recruitments, and developing its intellectual property group, which Fitch believes is reasonable.
Management is projecting profitability to improve in fiscal 2015, supported by the enhanced clinical operations at the new facility (2015 covers 11 months under the JOA). Profitability was improved year-over-year through the six month interim period ended Dec. 31, 2014, with a negative 4.9% operating margin compared to a negative 9.6% operating margin in the same prior year period. Fitch believes that the various strategic partnerships will begin yielding financial benefits in the next 12 to 24 months.
Joint Operating Agreement with St. Joseph Hospital
Effective August 2014, NJH formed a JOA with SJH, and began admitting patients at SJH's new hospital in December 2014, which is located just two miles from NJH's existing main campus. Under the JOA, NJH will receive a fixed percentage of NJH and SJH's combined Colorado operating income including both inpatient and outpatient activities (but excluding foundation activity). For the first 24 months, NJH will receive a certain minimum level of operating income from the JOA.
Fitch is concerned that the agreement ties NJH's portion of the income to the total JOA operations, to clinical services much beyond the services that NJH has historically provided. Net patient service revenues have historically contributed about 60% of NJH's total operating revenues, so the JOA is a fundamental change in NJH's revenue and income stream. Mitigating this concern is the credit strength of the SCLHS, a large 'AA' category health system, and that recent financial results show that SJH has been profitable.
Further mitigating near term concerns is the contractual obligation to distribute a minimum amount of operating income over the first two years. The financial benefits will be immediate as the amount to be distributed from the JOA is higher than what NJH has historically generated in operating income from clinical operations. Fitch will be better able to assess the JOA after the two year period, but believes the near-term risks in the JOA are very manageable at the current rating level.
Over the medium term, Fitch believes that the JOA has the potential to yield material clinical and financial advantages to NJH that has the potential to return NJH's rating to investment grade. NJH should be able to capitalize on revenue growth opportunities by having access to a larger network and being able to offer its patients a fuller continuum of care. Research should benefit as well through increased access to patients and clinical trials. Financial reporting should remain relatively similar to prior years, as assets and liabilities will remain separate.
Other Strategic Partnerships
In addition to the JOA, NJH has entered into several other partnerships in the last year with regional and national healthcare providers. During 2014, NJH worked with the Icahn School of Medicine at Mount Sinai to establish the Mount Sinai-National Jewish Health Respiratory Institute. The Institute opened in January 2015. This joint venture marked NJH's first venture outside Colorado, and capitalizes on the NJH brand, intellectual capital, recruiting platform, and clinical expertise. Management expects the financial benefits to accrue after the first year.
Over the last year, NJH also signed an agreement to provide electronic intensive care (nightly ICU coverage) for Banner Health (a multi-state system) and an agreement to provide pediatric pulmonology, allergy, and immunology services at Rocky Mount Children's Hospital in Colorado. The increased affiliation activity reflects NJH's strategy to expand its national presence leveraging its highly specialized expertise in respiratory services. Fitch positively views NJH's strategy to maintain its presence in a consolidating market increasingly dominated by large systems, and expects the organization to continue pursuing various partnerships.
Solid Development Activity and Manageable Capital Needs
Philanthropy activity is a credit strength, with annual fundraising levels of over $20 million. NJH is currently in the process of completing its largest campaign yet, with the goal of raising an additional $150 million that includes $100 million to fund a center for outpatient health, $20 million for an institute for lung health (research space), and $30 million for targeted faculty recruitments. Capital projects will be evaluated once sufficient amount of funds are raised.
Outside of the larger projects contingent upon fundraising success, capital plans are manageable and have been helped by NJH admitting to the new facility as part of the JOA. The annual capital budget is expected to be approximately $3.5 million to $4 million going forward, which is significantly below depreciation around $10 million. NJH's expansion projects outside of Colorado typically require little to no capital investments. The lower capital spending should help NJH preserve cash.
Decline in Liquidity
Unrestricted cash and liquidity declined year-over-year driven by negative cash flows and in part due to campaign pledges that have been committed but not yet received. However, liquidity and leverage indicators remain adequate for the rating category with 73.7 days cash on hand, 7.4x cushion ratio, and 77.4% cash to debt.
DEBT PROFILE
Total outstanding debt as of Dec. 31, 2014 was $52.9 million, which included $44.6 million in bonds and capital leases and $8.3 million drawn on an operating line of credit. Fitch treats the line of credit as long-term debt based on NJH's intentions to leave it outstanding for the foreseeable future. The bonds and capital leases are 77% fixed rate and 23% floating rate. The $11.1 million series 2005 variable-rate demand bonds are supported by an LOC from UMB bank that renews automatically (current expiration date is March 1, 2015).
Fitch uses a MADS figure of $5.5 million, which occurs in 2016. Per Fitch's calculations, coverage of MADS by EBITDA was a very low 0.6x in fiscal 2014, down from 1.4x in 2013. MADS coverage recovered to 1.5x through the six-month interim period (based on unrestricted activity). MADS drops to $4 million in 2018. There is a $6.3 million bullet maturity due in 2017 related to the 2011 Grove School Property Note, which Fitch excludes from MADS due to management's stated goals to pay off the note with fundraising and NJH's history of success with philanthropy.
While debt service coverage calculated per Fitch's definition are concerning, historical debt service coverage under the MTI is adequate. The MTI allows for inclusion of certain restricted philanthropic funds (Fitch's calculation only includes unrestricted) in revenues available and only use debt service on bonded debt, which was $3.5 million in 2014. Debt service coverage calculated under the MTI was 2.1x in 2014 and 6.4x in 2013.
DISCLOSURE
NJH covenants to disclose audited financial statements within 150 days of the end of the fiscal year. Quarterly unaudited financial information is disclosed within 45 days of the close of the first three quarters of the fiscal year and within 90 days of the close of the fourth quarter. Financial statements are posted to the Municipal Securities Rulemaking Board's EMMA system.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Revenue-Supported Rating Criteria', June 16, 2014;
--'U.S. Nonprofit Hospitals and Health Systems Rating Criteria', May 30, 2014.
Applicable Criteria and Related Research:
U.S. Nonprofit Hospitals and Health Systems Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=746860
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=979627
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